In-depth analysis of the US stock market circuit breaker mechanism: from Black Monday to the four consecutive halts in 2020

Throughout the history of the US stock market, there have been several impressive crash events, among which the most shocking was the four consecutive trading halts within just one month in 2020. What market mechanisms are hidden behind these events? Why are circuit breakers established? Can they truly protect investors? This article provides a comprehensive understanding of the secrets of the US stock circuit breaker mechanism.

Starting from Black Monday: The Birth of the Circuit Breaker

On October 19, 1987, the US stock market experienced a dark day. The Dow Jones Industrial Average plummeted by 508.32 points in a single trading day, a decline of 22.61%. This crash, known as Black Monday, quickly spread worldwide, with securities exchanges around the globe experiencing sharp declines within hours, causing unprecedented market panic.

It was this catastrophic crash that made regulators realize the need for an emergency mechanism to prevent market chaos. Thus, the US stock circuit breaker was born. The design of this mechanism was inspired by circuit breakers in electrical systems—when current overloads, the breaker automatically cuts off power to prevent fires. The same logic was applied to the stock market.

How the US Stock Circuit Breaker Works

The core principle of the circuit breaker is to hit the pause button during extreme market volatility. Specifically, regulators set three trigger points based on the S&P 500 Index.

During regular trading hours (9:30 AM to 4:00 PM Eastern Time), the circuit breaker is triggered in three levels depending on the percentage decline of the S&P 500 compared to the previous day’s close:

Level 1 Circuit Breaker occurs when the index drops 7%, pausing all stock trading for 15 minutes. If this occurs after 3:25 PM, no pause is triggered.

Level 2 Circuit Breaker is triggered if the index falls further to 13% within the same trading day, also pausing trading for 15 minutes. If this happens after 3:25 PM, no pause occurs.

Level 3 Circuit Breaker is triggered when the index drops 20%, which results in the immediate and full halt of trading for the remainder of the trading day. Regardless of when it occurs, a Level 3 halt means the market officially closes for the day.

It is important to note that Level 1 or Level 2 circuit breakers can only be triggered once per trading day. For example, if a 7% decline triggers a Level 1 halt, trading resumes, and if the index drops another 7%, it will not trigger another Level 1 halt unless the decline reaches 13% or 20%.

Why Is a Circuit Breaker Needed?

On the surface, the circuit breaker is a simple “pause button,” but the underlying logic is profound. Its primary purpose is to prevent excessive emotional reactions from investors from causing catastrophic market impacts.

When markets experience large swings, stock prices are often driven by panic. Seeing a market crash, ordinary investors tend to sell off instinctively, and this herd mentality can spread rapidly, ultimately leading to irrational market crashes and distorted prices.

Once the circuit breaker intervenes, it forces the market to pause. These 15 minutes or until market close provide investors with time to calm down and reassess the situation, rather than making decisions driven purely by fear.

Additionally, the circuit breaker can prevent phenomena known as “flash crashes.” For example, on May 6, 2010, a trader used high-frequency trading to create massive sell orders, causing the Dow Jones Industrial Average to plunge by 1,000 points within just five minutes. With the circuit breaker in place, the likelihood of such extreme events occurring is greatly reduced.

The Double-Edged Sword of Circuit Breakers

Theoretically, circuit breakers should serve as a protective umbrella for investors. They can indeed inject a “calming agent” during market panic, reducing excessive selling and allowing the market to gradually regain rationality.

However, reality is more complex. Some investors, when approaching the circuit breaker trigger points, may accelerate their sell-offs out of fear of being trapped during the trading halt. This behavior can actually increase market volatility and even create “circuit breaker traps.” In some cases, market expectations of circuit breakers themselves become a new risk factor.

Overall, the circuit breaker is like a double-edged sword—designed to stabilize the market, but its effectiveness depends on the actual reactions of market participants.

Review of Past Circuit Breaker Events

Since the official implementation of the circuit breaker in 1988, the US stock market has experienced 5 circuit breaker events:

October 27, 1997: The Asian financial crisis triggered global panic, with the Dow Jones falling 7.18%, triggering a Level 1 circuit breaker, and halting trading for 15 minutes.

March 9, 2020; March 12, 2020; March 16, 2020; March 18, 2020: The COVID-19 pandemic spread globally, leading to four consecutive Level 1 circuit breakers. These four halts occurred within just two weeks, setting a record in US stock history.

The most impactful circuit breaker event in 2020 occurred on March 18. That day, the S&P 500 dropped 7%, triggering the fourth trading halt within two weeks. Despite the US government announcing billions of dollars in economic relief measures and expanding stabilization fund loans, market sentiment still collapsed. The following Tuesday, after a 6% decline, the index triggered another Level 1 halt, with the Dow Jones dropping 2,999 points in a single day, a decline of 12.9%.

By March 18, the Nasdaq had fallen 26% from its February high, the S&P 500 had declined 30%, and the Dow Jones had dropped 31%. The crisis was rooted in factors such as the oil price war (Saudi-Russia negotiations breaking down causing oil prices to plunge) and worsening economic outlooks due to the COVID-19 spread.

The Difference Between Stock-Level and Market-Wide Circuit Breakers

Besides the market-wide circuit breaker targeting the S&P 500, US stocks also have individual stock circuit breakers (also called LULD mechanisms).

The market-wide circuit breaker is a “system-level” protection that triggers when the index falls to a set level. The individual stock circuit breaker protects specific stocks—exchanges set price limits for each stock. If a stock’s price exceeds these limits, trading is restricted for 15 seconds; if it does not recover within 15 seconds, trading for that stock is halted for 5 minutes.

Will There Be Future Circuit Breakers?

Investors often ask: Will the US stock market trigger circuit breakers again? The answer is likely yes.

Circuit breakers typically occur under the following circumstances: first, during unpredictable major sudden events, such as the COVID-19 pandemic or financial crises; second, when the market hits a high point and encounters unexpected external shocks, such as economic data releases that defy expectations or sudden policy rate hikes.

Current concerns about economic recession still exist, meaning the risk of circuit breakers remains.

If the US stock market triggers a circuit breaker again, investors’ strategies should be: first, do not panic excessively; second, adhere to a “cash is king” strategy to ensure capital safety and liquidity; third, during the halt, high-quality investment opportunities are often scarce. Instead of blindly bottom-fishing, it’s better to stay patient and prepare for subsequent continuous investments.

Summary

The US stock circuit breaker is an important tool for market self-protection. It automatically pauses trading when certain declines are reached, giving market participants time to think calmly. The three levels—7%, 13%, and 20% triggers—form a layered protective system.

From the market crash on Black Monday in 1987 to the pandemic shocks in 2020, the circuit breaker mechanism has witnessed the most difficult moments in market history. While not a perfect solution, it has indeed reduced the risk of extreme market volatility to some extent. Understanding how the circuit breaker works helps investors make more rational decisions during intense market swings.